Week in Review

The American left wants more government intervention into the free market. Because they hate and don’t trust corporations. Because they are motivated by profit. Even putting profits before people. Whereas government puts people before profits. So everything is better when government intervenes. Which is why the left loved Hugo Chávez in Venezuela. They love Cuba. They loved the former Soviet Union. Because they were all socialist utopias. Where they put people before profits. Of course, people are robbing women of their hair in Venezuelan streets. Cubans have risked their lives crossing the ocean to reach Florida on just about anything that floats. And the Soviet Union is no more. Because they couldn’t provide for their people. Despite putting their people before profits.

Another communist country the left likes is Vietnam. Especially since the communists got the Americans to give up and go home. Vietnam is still communist. But like China they add a sprinkling of capitalism to the communist stew. A sort of state-capitalism. Capitalism with the heavy hand of the government involved. The way the American left likes it. And how are things there? Well, they are having quite the problem in their coffee industry (see Crippling debts brew a coffee crisis in Vietnam by Nguyen Phuong Linh, Ho Binh Minh and Lewa Pardomuan posted 8/15/2013 on The Globe and Mail).

But its coffee industry is now in crisis, plagued by tax evasion, mismanagement, insolvency, high interest rates and a credit squeeze. Many coffee operators are trapped with crippling debt and banks are reluctant to lend them more money.

Vietnam’s credit crunch is blamed largely on state-owned enterprises that borrowed big during the economic boom of the past decade and squandered cash on failed investments, which has left banks crippled by one of Asia’s highest bad-debt ratios…

Few coffee exporters are willing to talk about their financial problems. In communist Vietnam, people are often reluctant to speak publicly about politics and business, especially to foreign media…

Vietnam’s 2013-2014 coffee crop is forecast to be a bumper harvest, around 17 million to 29.5 million 60-kg bags, based on a Reuters poll. This will add to a global oversupply and pressure coffee prices which have lost about 10 per cent since October…

A government assessment of the coffee industry paints a bleak picture. The value of non-performing loans or debts in the sector likely to go unpaid stands at 8 trillion dong ($379-million), or 60 per cent of all coffee industry loans, said a July circular signed by the Deputy Agriculture Minister Vu Van Tam…

Unscrupulous middlemen have also played a part in the crisis, cheating exporters by selling them weighted coffee bags and inferior beans which are difficult to sell or fetch lower prices.

“What I found out is the market there is quite dirty. Middlemen often sell poor beans to exporters. They even put metal bolts in the bags to outweigh them,” said Joyce Liu, an investment analyst at Phillip Futures in Singapore.

You don’t have middlemen putting bolts into bags to make them heavier in free market capitalism. For any inferior product in a free market doesn’t remain long in a free market. As people will simply stop buying an inferior product. And it could take years for a company to rebuild its tarnished image. If they ever can. This is what happens when you put profits before people. People win.

So who caused the credit crunch? State-owned enterprises. As people in government are horrible at business. For if they were good at it they would be in it. But they’re not so they regulate it. Or run a state-owned business. Not because of their business acumen. But because they had friends in higher places in government than anyone else.

Loans are important in any agricultural business. Because all of your expenses come long before you can sell anything. So they take on big debts at the beginning of the season. That they plan on repaying after the harvest. As long as prices don’t fall because there is a bumper crop. But if they do they may not be able to earn enough to repay their bank loans. Which is why 60% of all coffee industry loans will likely go unpaid. And why bankers don’t want to loan them any more money. Or charge a really high interest rate when they do. For if a banker knows that every other loan he or she writes will never be repaid it makes a banker very reluctant to loan any money. And what they do loan has to have such high interest rates to cover the loans that are never paid back.

This is why governments should not interfere with free markets. For when they do they just make everything worse. Because they’re just not good at it. Unlike oppressing their people. That they’re very good at. Which is why people are “reluctant to speak publicly about politics and business, especially to foreign media.” Something unheard of in free market economies. But quite common in these socialist utopias. Yet the left still favors them over free market capitalism. Go figure.

Economics 101

A Command Economy Reduces the Overall Economic Output because those Managing the Economy don’t Understand It

Command economy? Or free market capitalism? Which works better? Well, let’s find out with a little experiment. Let’s go back in time. Say ancient Mesopotamia. Just after they developed mass farming. And produced some of the first food surpluses. Allowing the rise of a middle class of artisans. Now let’s look at what could have been the first two of these artisans. A potter. And a winemaker. Who probably weren’t the first two artisans. But will suffice for our little experiment.

The winemaker needs some pottery vessels to store and sell his wine in. And the potter enjoys drinking wine. They each have something the other wants. And because we’re so far back in time there is no money yet. We’re still only bartering at this time. Trading the goods we make with each other. But in our experiment the high priest of the civilization is also the economic planner. This priest communicates to the civilization’s gods. And guides the civilization in pleasing their gods. Which he is very good at. For he knows all of the old teachings and rituals. But he doesn’t know a thing about pottery or winemaking. But he looks at an empty pottery vessel and a pottery vessel full of wine and sees that the vessel volume equals the volume of wine. And deems the price of one pottery vessel is the amount of wine one pottery vessel holds.

Well, the potter is quite happy with this price. Because he is skilled. And can dig up some clay. Throw it on the potter’s wheel and knock out vessel after vessel. Glaze them and fire them in the kiln. Even working by himself he can achieve some economies of scale. By repeating this process every day. Something the winemaker isn’t quite able to. For he makes wine by the batch. Because each step in the process takes a lot of time. Maintaining his grape vines. Then picking the grapes. Carrying them back to his winery. Putting them into his winepress. Squeezing the juice out of the grapes. Putting the grape juice in large vats to ferment. Monitoring the process. When he determines the process is complete he fills the small pottery vessels with wine. When it was finally ready for ‘sale’ and consumption. Considering all the work it took him to make one vessel of wine the winemaker was not at all happy with the price the high priest set. And instead builds his own potter’s wheel and kiln to make his own vessels. Greatly increasing his workload. And reducing his winemaking output. While the potter loses a potentially large customer. Thus reducing the amount pottery he makes. Reducing overall economic output in the command economy.

The Invisible Hand makes sure we use our Limited Resources Efficiently to Make the Things People want Most

In this command economy the civilization suffered a deadweight loss. Economic resources went unused. They could have created more economic benefits with the available resources. They could have made more pottery. And made more wine. Perhaps even creating some jobs to help with the economic output of efficiently using the available resources. But they didn’t. Because of the fixed prices economic resources went unused. Thus creating a market equilibrium lower than where it could be. Hence the deadweight loss. Now let’s look at the same example with only one difference. The high priest does NOT set prices.

In a barter economy people agree to trade the goods they make. And now the potter and the winemaker are free to determine what they think is a fair trade. That is, they set the price of pottery in wine. And the price they agree on is one they find mutually acceptable. Where the potter agrees to trade an amount of his pottery for an amount of wine. And the winemaker agrees to trade an amount of his wine for an amount of pottery. Everyone wins. For the potter gets an amount of wine he values more than the pottery he traded for the wine. The winemaker gets an amount of pottery he values more than the wine he traded for the pottery. And the civilization wins because at this mutually agreed upon price both the potter and the winemaker increase their production. Providing the civilization with more of their goods. The potter and the winemaker may even hire people to help them produce more goods to meet this higher demand. Thus increasing the level of happiness in the civilization. By increasing the amount of economic activity. Moving the market equilibrium to a higher level of economic output. And thus reducing the deadweight loss. By using the available resources in the most efficient manner. As determined by these mutually agreed upon prices.

This is the Invisible Hand in action. An economic concept put forth by Scottish economist Adam Smith (1723-1790) in his The Wealth of Nations (1776). In a competitive market place where traders set the price for their economic trade (not a command economy) two things happen. First, resources flow to where we demand them most. That is, to the buyers willing to pay the highest price. Second, because of the competitive market place only those companies that sell at the low prices the market demands stay in business. Which means that they have to use those resources as efficiently as possible. Especially when they’re paying the highest prices for them. And all of this happens because of the Invisible Hand.

History has Proven that no Government Bureaucrat can do a Better Job than the Invisible Hand

Those who favor a command economy (or more government intervention into market forces) say the economy is too complex for us to leave it to its own devices. That without a smart government bureaucrat managing this complex thing we cannot reach a market equilibrium that maximizes economic output. Whereas Adam Smith says it is because the economy is so complex that no one is smart enough to manage it. Just as a high priest doesn’t understand pottery or winemaking a smart government bureaucrat cannot hope to understand all the intricacies of a complex economy. Nor can they ever hope to understand what millions upon millions of consumers want to buy most. But the beautiful thing is we don’t have to.

The multitudes make individual decisions just like our potter and winemaker. Where everyone is looking to maximize their own value. And when they agree on a mutual acceptable price all parties in the trade win. While making sure our resources flow to where they are demanded most. And that we use these valuable and limited resources most efficiently. Thus maximizing overall happiness in our country. Reducing deadweight losses to a minimum. And obtaining a market equilibrium that maximizes economic activity. All of which happens with no one in charge. As if an Invisible Hand guides us in the market place to make all the right decisions to maximize this economic output. And our happiness.

So which is better? Command economy or free market capitalism. Well, if you’re being honest you have to choose Adam Smith’s Invisible Hand and free market capitalism. For history has proven that no government bureaucrat can do a better job than the Invisible Hand. Not the Soviets. Not the Chinese Communist (under Chairman Mao). Not the Cubans. Not the North Koreans. Even the Americans failed when their government actively intervened in the private economy. Something that President Jimmy ‘one-term’ Carter knows only too well. So based on our hypothetical Mesopotamian example, and history in general, free market capitalism is, and always has been, and always will be, better than a command economy.

Week in Review

No matter how many times their policies fail those on the left never give up. The free market capitalism that gave us the Industrial Revolution was not as good as the mercantilism it replaced. The free market capitalism that won World War II was not as good as Nazi Germany’s National Socialism. The free market capitalism that won the Cold War was not as good as the Soviet Union’s communism. No, any economic system that doesn’t place smart people in the government (and from our most prestigious universities) in charge is an inferior economic system. At least, according to those on the Left (see There Is No Invisible Hand by Jonathan Schlefer posted 4/10/2012 on the Harvard Business Review).

One of the best-kept secrets in economics is that there is no case for the invisible hand. After more than a century trying to prove the opposite, economic theorists investigating the matter finally concluded in the 1970s that there is no reason to believe markets are led, as if by an invisible hand, to an optimal equilibrium — or any equilibrium at all. But the message never got through to their supposedly practical colleagues who so eagerly push advice about almost anything. Most never even heard what the theorists said, or else resolutely ignored it.

Interesting. Using the economists of the Seventies as the authoritative position for government interventionism into the economy. Why, that would be like having the captain of the Titanic being the authority on how to miss icebergs in the North Atlantic.

The Seventies were the heyday of Keynesian economics. Where the government was aggressively intervening into things economic. And the results of their policies were so bad that we had to create new words to describe it. Like stagflation. A heretofore unheard of phenomenon. And something that just wasn’t supposed to happen when the Keynesians used inflation to lower unemployment. But it did. Even though you weren’t supposed to get inflation and high unemployment at the same time. Stagflation. Like we did. In the Seventies.

Believing far too credulously in an invisible hand, the Federal Reserve failed to see the subprime crisis coming. The principal models it used literally assumed that markets are always in instantaneous equilibrium, so how could a crisis occur? But after the crisis exploded, the Fed dropped its high-tech invisible-hand models and responded with full force to support the economy.

The subprime mortgage crisis was a government-made crisis. Precisely because government refused to allow the Invisible Hand to guide the market place. Instead they stepped in. Forced lenders to make risky subprime loans to people who couldn’t qualify for a mortgage. With tools like the infamous Adjustable Rate Mortgage (ARM). And then they had Fannie Mae and Freddie Mac buy those risky mortgages. To get them off the lenders’ balance sheets so they would make more risky loans. Then Freddie and Fannie chopped up these risky loans and repackaged them into ‘safe’ investments to unload them to unsuspecting investors. Getting these toxic mortgages off of their balance sheets. (In case you don’t know, Fannie and Freddie are Government Sponsored Enterprises (GSE). Which are for all intents and purposes the government.) This house of cards imploded when the Fed raised interest rates. After keeping them below what the Invisible Hand would have set them at for far too long. The government created the real estate bubble. Then blew it up when those higher interest rates reset all the AMR mortgage payments beyond the homeowner’s ability to pay.

There are many economists in the world. And the consensus of economic thought tends to be one that supports large government intervention. Which proves the economic consensus is wrong. For if history supported this consensus the Soviet Union would have won the Cold War. East Germany would have absorbed West Germany. China would not be experimenting in ‘Invisible Hand’ capitalism. And Cuba wouldn’t be experimenting with a little capitalism themselves to fix their broken government command economy.

All these market failures economists like to point to aren’t market failures. They are the unintended consequences of government intervention into the market. As the subprime mortgage crisis clearly proved. Which never would have happened in the first place if the government didn’t try to be smarter than the Invisible Hand.

History 101

The Twenties saw one of the Greatest Explosions in Economic Growth in History despite being on a Gold Standard

There is a duality in economics. There is Keynesian economics. And the Austrian School. The Keynesians believe in central banking. Forcing interest rates below market rates. Purposely creating a permanent but ‘manageable’ inflation rate. And other government interventions into markets. The Austrians believe in a strong currency. Even bringing back the gold standard. Letting the markets set interest rates. Are against purposely creating inflation. And oppose government intervention into markets. So these two schools are sort of the Yin and Yang of economics. The dark and the light. The wrong and the right. The Keynesian and the Austrian.

So it’s not surprising to see periods of history where these two schools bump up against each other. As we transition from good economic times to bad economic times. And vice versa. When politicians change policies for political reasons. Or when politicians change policies for economic reasons. When the Keynesians are out of power and want to get back into power. Or the Keynesians are in power, have destroyed the economy and the electorate wants to throw them out. Starting shortly after World War I. When John Maynard Keynes’ ideas came to light. Economic policies that used smart people and an active, benevolent government. Exactly what Woodward Wilson and his progressives were looking for. Who wanted to quantify human behavior and improve it. With an activist and scientific government. To bless the United States with their brilliance again now that the war was over. And return to the new enlightened way. Helping people everywhere to be better citizens. And fixing all the ‘faults’ of free market capitalism.

But the progressives lost the 1920 election. The voters favoring Warren Harding’s message to return to normalcy. And rejecting the progressives and their new scientific ways of government. They wanted jobs. And that’s what Harding gave them. By cutting taxes. Thanks to the advice of his brilliant treasury secretary. Andrew Mellon. And getting out of the way of businesses. When he died Calvin Coolidge continued his policies. And the Twenties roared. It was one of the greatest explosions in economic growth in history. Where credit was plentiful. Despite being on a gold standard. As the United States electrified. And modernized. Electric power. Telephones. Radio. Electric appliances. Movies. Even on the farm. Where mechanization provided bountiful harvests and inexpensive food. The Roaring Twenties were great times for consumers. The average American. Thanks to minimal governmental interference into the free market. And capitalism. But, alas, that wouldn’t last.

Ronald Reagan won in a Landslide based on an Economic Platform that was Austrian to the Core

It was the mechanization of the farm that began the process that lead to the Great Depression. The average American benefited greatly from those low food prices. But not the farmers who went into debt to mechanize their farms. And when those European World War I soldiers traded their rifles for plows the American farmers lost some valuable export markets. Farmers were struggling with low prices. And heavy debt. Some defaulted on their debt. Causing bank failures in the farming regions. Which soon spread throughout the banking system. And when president Hoover came to office he was going to help the farmers. For Hoover, though a Republican, was a progressive. He brought back activist government. He interfered with the free market. To fix these problems. Price supports for farmers to import tariffs. Raising costs for businesses. And prices for consumers. Then the Smoot-Hawley Tariff launched an all out trade war. Crashing the economy. And giving us the Great Depression.

The 1930s was a lost decade. FDR’s New Deal policies increased the size of government. And their reach into the free market. Which prolonged the Great Depression. But nothing they tried worked. Despite trying their progressive brilliance for some ten years. It took World War II to pull the United States out of the Depression. When the government at last allowed businesses to pursue profits again. And got out of their way. This surge in economic activity continued after the war and through the Fifties. And into the Sixties. With none other than JFK cutting taxes in a very Austrian way. Yes, Kennedy was an adherent to the Austrian school. But LBJ wasn’t. And when he took over things changed. The progressives were back. Calling themselves liberals now. And instead of the New Deal they gave us the Great Society. Which grew the government even larger than the New Deal did. And the Great Society spent the money. Along with putting a man on the moon and the Vietnam War, government spending exploded. The Keynesians were hitting their prime. For once they could do all of the great things they always said they could. And in the process fix a ‘broken’ free market system. Finally having brilliant people in all the right places in government. Making brilliant policies to help people live better lives.

And then came the Seventies. The government was spending so much that they turned to the printing presses. Because they could. Thanks to central banking. Even if it was hamstrung by gold. You see, at that time the dollar was convertible into gold. And with the Americans printing so much money and depreciating the dollar countries holding U.S. dollars said, “Screw that.” And converted their dollars into gold. That great sucking sound they heard in the Seventies was the sound of U.S. gold reserves getting sucked out of the country. Well, even though the Keynesians hated gold they didn’t want to see all their gold reserves disappearing. So Nixon did something very Keynesian. And decoupled the dollar from gold. Freeing the government at last to spend as irresponsibly as the Keynesians wanted. And spend they did. Turning the printing presses on high. Depreciating the dollar ever more and causing double digit inflation. Worse, all that Keynesian spending did nothing for the economy. There was high unemployment as well as inflation. An unusual phenomenon as you typically had one or the other. Not both. But this was stagflation. A Keynesian phenomenon. And you measured how bad it was by adding the unemployment rate to the inflation rate. Giving you the misery index. And the misery was pretty high during the Keynesian Seventies. It was so miserable that they joked about it on Saturday Night Live. With Dan Aykroyd impersonating Jimmy Carter. Joking about high nice it would be to own a $400 suit. And how nice it was just to make a phone call to get the printing presses to print more money. The people thought Aykroyd’s Carter was funny. But they didn’t care for the real one all that much. And made him a one term president. As Ronald Reagan won in a landslide. Based on an economic platform that was Austrian to the core. Including a promise to return responsibility to government spending by reinstating a gold standard. (Which was a political ‘bridge too far’.)

The Electorate paying Federal Income Taxes fell from 80% when Reagan was in Office to about 50% by 2009

The Eighties were so prosperous that the Keynesians, liberals and progressives derisively call them the decade of greed. They tried everything within their power to rewrite history. Calling the exploding economic activity ‘trickle down’ economics. But the figures don’t lie. Despite the liars figuring. The inflation rate fell. Interest rates fell. The unemployment rate fell. And despite the cuts in tax rates the government was never richer. Tax revenue collected under the reduced rates nearly doubled. But there was little cutting in government spending. Flush with all that cash they kept spending. In part to rebuild the military to win the Cold War. Which Reagan won. But all the social spending continued, too. Which led to some record deficits. Not the trillion dollar deficits of the Obama administration. But large nevertheless. Which provided the meme to explain away the prosperity of the Eighties. “But at what cost?” being the common refrain. They talk about the deficits. But very conveniently leave out that part of how tax revenues doubled at the reduced tax rates.

Well, as time passed the Keynesians got back into government. In the late Nineties as they kept interest rates low again to stimulate the economy. Creating the dot-com bubble. And the early 2000s recession. George W. Bush cut taxes. Brought the economy out of recession. But then the Keynesians went back to playing with those interest rates. Kept them artificially low. Creating a great housing bubble. And the Subprime Mortgage Crisis.

Keynesian economics have failed throughout the last century of trying. And taxpayers clearly saw this along the way. Voting for Austrian policies every time economic policy mattered. Especially after another failure of Keynesian policy. Every time their policies failed, though, the Keynesians had an excuse. Supply shocks. Liquidity traps. Something. It was always something that caused their policies to fail. But it was never the policies themselves. Despite Mellon, Harding, Coolidge, Kennedy and Reagan proving otherwise. So they had to try something else. And they did. Class warfare. They transferred the tax burden to the wealthier. Reduced the number of people paying federal income taxes. And gave ever more generous government benefits. This took the failed ideology out of the equation. Making it easier to win elections. For when Reagan was in office more than 80% of the electorate were taxpayers. And Austrian economics won at the polls. The Nineties ended with only about 65% of the electorate paying federal income taxes. By 2009 that number shrunk to about only half of the electorate. Which gave the tax and spend Keynesians an edge over responsible-governing Austrians. Because people who don’t pay income taxes will vote for policies to increase taxes on those who do. Not because of concern over economic policy. But just to get free stuff. Something Keynesians learned well. When at first you fail just buy votes. And then you can continue your failed policies to your heart’s content.

A Generous Government robs the Private Sector

The economy. It’s bad today. It’ll be bad tomorrow. And probably will still be bad when many are thinking about retiring. I say thinking. Because that’s all they may be able to do about retirement. Think about it. As they keep working well into retirement age (see Retirement As We Know it Is “Dead”: EuroPacific’s Pento by Peter Gorenstein posted 6/22/2011 on Yahoo! Finance).

“Americans are have negligible savings, the real estate market is still in secular decline, stock prices are in a decade’s long morass, real incomes are falling, public pension plans are insolvent and our entitlement programs are bankrupt.”

Pento believes these issues could be resolved if the government takes the right steps. What might those be? He recommends lowering taxes, reducing inflation and balancing the budget as a means to increase the value of the dollar. If the dollar had more purchasing power and interest rates were higher, retirees would be able to live off their fixed income, he says.

Please note the common theme in the resolution. Less government. Less government spending. Les government taxing. Less government quantitative easing (i.e., stop depreciating the dollar). Because it is all of this government intervention into the private sector that has killed so many private sector jobs. Reduced our real incomes. Bankrupted our entitlement programs. And destroyed our pensions (because fat pension funds are just too tempting to ‘borrow’ from to pay for more spending. And by borrow I mean steal).

A generous government is a government that robs the private sector to pay the beneficiaries of the public sector. But they have taken so much that they have given the private sector the worst recession since the Great Depression. Which, in turn, has starved government coffers. Talk about killing two birds with one stone.

There’s no Recession in Bourbon Country

Despite being in the worst recession since the Great Depression thanks to all that government intervention into the private sector, there is some positive economic activity out there. One area in particular that is near and dear to my heart. Bourbon (see Bourbon’s popularity feeds growth of Kentucky distilleries by Bruce Schreiner, Associated Press, posted 6/25/2011 on USA Today).

The producers are aiming to quench a thirst for bourbon — especially premium brands — that is steady in the U.S. and rapidly expanding overseas, thanks in part to the comeback of cocktails appealing to younger adults, lower tariffs, robust marketing and a larger middle class in emerging markets.

A tariff is a tax on an import. To protect the domestic competition. Or so goes the theory. Protective tariffs destroyed a lot of American industry that had no incentive to improve (textile, steel, automotive, etc.). But that’s another story. Thankfully, bourbon is an American spirit. All proper bourbon hails from Kentucky. Thanks to those freshwater streams through the limestone bedrock of those rolling hills. So there are no foreign bourbon markets to protect. Keeping tariffs lower than they may be otherwise. Thus providing a healthy export market.

Industry observer F. Paul Pacult, editor of the quarterly newsletter Spirit Journal, said bourbon makers are showing an adventurous side with premium offerings that reflect an “intramural competition.”

“There’s more innovation happening in Kentucky right now than any other place in the world,” Pacult said.

Now Kentucky is bourbon country. There are a lot of distillers competing against each other. And yet the bourbon market as a whole is growing. There’s no recession in bourbon country. Which just goes to prove the old maxim. Competition makes everything better.

The industry’s biggest boost, though, has come from exports.

Producers of bourbon and Tennessee whiskey reaped $768.2 million in export sales in 2010, up from $303.8 million in 2000, according to the spirits council, citing statistics from the U.S. Department of Commerce and the U.S. International Trade Commission.

The biggest overseas customers include Australia, Japan, the United Kingdom and Germany, but the industry is looking at two seemingly bottomless markets — China and India — along with other emerging markets in Asia and Africa.

China and India. Those two countries driving up the price of oil. Because of exploding demand in their emerging middle classes. Countries that gave up much of their communist/socialist ways. Who turned their disdain for capitalism to ‘dain’ (which I think means the opposite of disdain). And they have smoking hot economic growth. Hard to believe that a communist country, China, is schooling the United States in free market capitalism.

Crony Capitalism and Corruption in China

Or are they? Oh, they are getting more Western. But not like the UK or the USA during the Industrial Revolution or the booming times that followed. But after the growth of Big Government in those counties (see The long arm of the state posted 6/23/2011 on The Economist).

Chinese students used to aspire to a job with a foreign company. Now they are more likely to want one with an SOE [state-owned enterprises].

This may seem an odd choice, since the dynamism in China’s economy is mostly generated by non-state firms… In 1999 government-controlled firms owned 67% of industrial capital; a decade later their share had fallen to 41%. But in the industries that pay the highest salaries, state firms dominate.

A new shorthand has entered common parlance: guojin mintui, meaning the state [sector] advances and the private retreats. ..It has been tightening its grip on some industries it considers “strategic”, from oil and coal to telecommunications and transport equipment. It has been devising market-access rules that favour state firms. And to the chagrin of private businesses, it has allowed state companies to remain active in a surprising range of palpably non-strategic sectors, from textiles and papermaking to catering. In recent years property development has become a lucrative sideline for government businesses. “The tentacles of state-owned enterprises extend into every nook where profit can be made,” writes Zheng Yongnian of the National University of Singapore.

Already the young people are choosing the public sector over the private sector when it comes to their career. Because the bloated public sector pays more. With this higher pay they must be attracting the best and brightest to these SOEs. So these SOEs must be kicking the non-state firms’ asses.

Some Chinese economists worry that the government’s response to the global financial crisis will bolster state enterprises and their bad habits at a time when they urgently need reforming. As the confederation’s researchers put it, much stimulus spending has involved “swapping from the left hand to the right hand”: the state lending to the state…

Unirule noted that the profits of state-owned industrial companies had increased nearly fourfold between 2001 and 2009. But their average return on equity was less than 8.2%, whereas that of larger non-state industrial enterprises was 12.9%. Factor in the low cost of borrowing enjoyed by SOEs and their access to land at below-market prices, the report said, and their real return on equity between 2001 and 2009 was minus 1.47%. They are, in effect, destroying capital.

Apparently not. They actually have a negative return on investment. So the SOEs are just deadwood propped up by government spending and special privilege. Reminds me of another Asian country awhile back. Where there was private sector/public sector partnering. Where capital was shuttled from the left hand to the right hand. Anyone like to guess the country I’m thinking about? Anyone? No? Here’s a hint. China and this other country hate each other. Bitterly. Which makes it rather ironic that they’re now following their example. That Asian country is Japan. During the Eighties. A decade of spectacular growth. That was more bubble than growth. And we all know what happened in Japan in the decade that followed. Not a whole hell of a lot. Because the bubble popped. And they suffered a devastating deflationary spiral similar to the Great Depression. It was so bad that they called the Nineties the Lost Decade.

Some foreign businesspeople complain that market-opening measures initiated in the 1990s and early 2000s have run out of steam. Many saw China’s accession to the WTO ten years ago as a great impetus for reform. But when the country reached the end of its transition period in 2006, its will faltered. Many foreign companies still report doing good business. But especially since the global financial crisis, the government has been widely accused of twisting rules in favour of its state-owned or, sometimes, private-sector favourites…

Local governments sometimes play a decisive role in determining which firms succeed and which fail. Take Himin, a manufacturer of solar water heaters based in the city of Dezhou in the northern province of Shandong. Himin is a private company, but it is the local government’s champion. Together Himin and the government have devised a branding strategy for Dezhou as China’s “solar city”. The government has helped Himin to grow by requiring apartment buildings to be equipped with solar water heaters and by subsidising solar-heated bathhouses in villages.

This is not capitalism. This is crony capitalism. Not much different from mercantilism. And not a sustainable economic model. Unlike entrepreneurism. Like they’re doing in Kentucky. While the nation is suffering the worst recession since the Great Depression, distillers are investing and innovating, competing against each other as they book record exports. Without any partnering with their government. While Himin is in bed with government. A government that giveths. And can just as easily taketh away. And with business dependent only on their relationship to government, you can bet that there isn’t a lot of investing and innovating going on at Himin. Because they don’t have to. So why would they?

This scheme to encourage what the government calls “indigenous innovation” focuses on seven “strategic” industries, from alternative energy and low-carbon-emitting vehicles to information technology. First Financial Daily, a Chinese newspaper, reported that investments by these industries could amount to as much as $1.5 trillion over five years, of which the state is likely to contribute 5-15%. Mr McGregor says the scheme involves creating new Chinese technologies on the back of foreign ones supplied by companies eager for a share in the government’s massive spending. Some Chinese scientists have complained about the likely waste involved in state-directed R&D, but the party loves big projects too much to listen.

Good innovation doesn’t need government money. Investors are more than willing to finance a good thing. What investors don’t like to invest in are bad investments. Which is typically what the government invests in. Because a good investment can attract private capital. So that leaves the bad investments for government to fund.

People flocking to the government for financing are just like ants at a picnic. They just want to get in while the getting is good. But they have little of value to offer. They’ll just pull a lot of money out of the private sector that could have been put to better use. By producing real economic growth. With a positive return on investment.

Worse is the state directing private investment. People risking capital know what good R&D is. People risking other people’s money don’t. And they’re far more tempted to consider political reasons than good science.

China’s state-sector reforms in the 1990s went for the low-hanging fruit. A decade ago angry workers were easily cowed into submission by police or bought off with handouts. But any further reform would affect the interests of people in the top echelons of the party as well as their families, who have extensive connections with state-owned firms.

Zhu Rongji, the former prime minister whose reforms obliterated many of China’s state-owned firms in the late 1990s, has also gone on the attack. In April he made a rare public appearance at his alma mater, Tsinghua University. He handed over copies of a four-volume collection of his speeches, due to be published later this year, and pointedly invited readers to “make comparisons with the situation today”. To his supporters, the present looks grim.

Top echelons of the ruling communists, as well as their families, are well connected with state-owned firms? No wonder they have negative returns on equity. They’re stealing money from these SOEs. This is everything the communists said the capitalists did. And here the wealthy communist elite are doing it themselves. Exploiting the poor working class. How ironic.

Maybe the Chinese are just drunk with power. Or on that fine Kentucky bourbon.

You’re going to Work until you’re Dead

The Chinese economy is a house of cards. Much like it was in Japan in the Eighties. And it will crash. One day. Just as the Japanese economy fell. And no doubt a round of deflation will follow. Like in Japan. The Chinese are already raising interest rates to stamp out inflation. To try and stop a bubble in their economy. Much like the rest of world is. Well, pretty much everyone but Ben Bernanke in the U.S. Who may still try another round of quantitative easing. Silly Americans. Adding inflation to high unemployment only gets you the misery of the Seventies. Carter‘s stagflation.

Although some of that economic activity may be somewhat artificial, it is producing surpluses. Enough for the Chinese to buy U.S. debt. So the Americans can continue to pay for their entitlement programs. Such as Social Security. And Medicare. Which everyone and their brother knows will go bankrupt in the not so distant future. Just as the Baby Boomers start retiring en masse to stress these programs like they’ve never been stressed before. Now imagine the Chinese economy crashing. And their surpluses turn to deficits. And they can’t buy U.S. debt anymore. That’d be one painful scenario. Unable to borrow money, the U.S. would have no choice but to cut spending. In a big way. As in all those entitlement programs. Which account for almost half of all federal spending. Ouch.

Retirement as we know it dead? You better believe it. You’re going to work until you’re dead. Even if you saved for your own retirement. Because a broke government is a desperate government. And if they can’t raise enough money taxing income, and the Chinese aren’t buying our debt, they’ll start taxing your wealth. Your savings. Your assets. Your retirement. Some nations already do. So it’s not unprecedented. Which would make a Chinese crash rather depressing.

He won’t Drill but he will Draw from the Strategic Reserve

The Great Recession lingers on. As high oil prices hit consumers hard. Gas prices are back to $4/gallon territory. Leaving consumers with less disposable income. Home values are declining in a deflationary spiral. Wages are stagnant. Unemployment is high. And there’s inflation in food and consumer goods. All driven by the high price of oil. And all that quantitative easing (QE) that has depreciated the U.S. dollar (which we buy and sell oil with in the global market).

The demand for oil is soaring. And yet President Obama put a moratorium on drilling in the Gulf of Mexico. In fact, the U.S. isn’t drilling anywhere. Which has forced the U.S. to import more foreign oil. Because of this squeeze on supply. Economics 101 tells you when demand increases supply should increase to meet that growing demand. When it doesn’t, prices rise. Like they are. And the QE just compounded that problem. When the dollar is worth less it takes more of them to buy the same amount of oil it used to. Which means higher prices at the pump. From demand outpacing supply. And a weaker dollar.

The president’s solution to the high gas prices? Blame the oil companies. Because their profits were too high. It had nothing to do with his policies that restricted the supply of oil on the market. Of course, with an election coming up and gasoline prices too close to $4/gallon, he’s changed his position on that (see Loss of Libya oil bigger disruption than Katrina: IEA by Simon Falush and Zaida Espana posted 6/24/2011 on Reuters).

On Thursday, the International Energy Agency which represents the major oil consumers agreed to release 60 million barrels from emergency stockpiles, sending crude prices tumbling.

Imagine that. Increase supply. And prices fall. For awhile, at least. Because once these 60 million barrels are gone, the prices will just go back up where they were. Unless there is a real increase in supply. Like more drilling in the Gulf. The Atlantic. The Pacific. In Alaska. We know it works. Increase supply. And prices fall. So why not just increase supply with more drilling? Instead of drawing down our strategic reserves (America’s share being 30 million of the 60 million barrels). Which, incidentally, we’ll have to replace.

Energy Policy Driven by the 2012 Election

So on Thursday Obama administration spokesman Jay Carney argued that oil demand is likely to rise over the summer. In other words: It’s vacation season, and the White House is worried about high prices through the summer driving months.

Therein, perhaps, is a political emergency, at least in the White House view: President Obama’s reelection prospects will be harmed if national discontent over high gasoline prices continues. The oil release could be seen as a way for the president to take credit for gas prices that are falling anyway, or as an indirect, pre-election stimulus.

Personally, the president doesn’t have a problem with the high cost of gasoline. His administration wants it high. The higher the better. They’d like to see it European high (see Times Tough for Energy Overhaul by Neil King Jr. and Stephen Power posted 12/12/2008 on The Wall Street Journal).

In a sign of one major internal difference, Mr. Chu [who became Obama’s Energy Secretary] has called for gradually ramping up gasoline taxes over 15 years to coax consumers into buying more-efficient cars and living in neighborhoods closer to work.

“Somehow we have to figure out how to boost the price of gasoline to the levels in Europe,” Mr. Chu, who directs the Lawrence Berkeley National Laboratory in California, said in an interview with The Wall Street Journal in September.

To make the more expensive green energy less expensive in comparison. And an easier sell to the American people. Pleasing his liberal base. But there’s an election coming. And high gas prices don’t help you win elections. Especially during record long-term unemployment. Even though it goes against every fiber in his body to act to bring down the cost of gasoline, he will. If it’ll help his reelection chances. It’s not like he’s going to lose his liberal base. Who else are they going to vote for? The conservative? Not likely. They’re always going to vote for the most liberal candidate in the race. And that will still be him. Despite encouraging more oil consumption.

The Fed doesn’t know why the Economy is in the Toilet

The president needs to get the price down at the pump. Where people really feel the full weight of his economic policies. Because the economy isn’t going to get better anytime soon (see Serial disappointment posted 6/23/2011 on The Economist).

THE Fed attracted attention this week for downgrading its forecast not just for this year, but for 2012, as well. More striking is how often it does this. As my nearby chart shows [follow the above link to see chart], the Federal Open Market Committee has repeatedly ratcheted down its forecasts of out-year growth. The latest downward revision is particularly large, and in keeping with the pattern: when the current year disappoints, they take a bit out of the next, as well.

There’s been a steady downward progression of economic projections. Despite the stimulus. And the quantitative easing. Nothing has worked. When the chairman of the Federal Reserve, Ben Bernanke, was asked why the economy was not responding to the government’s actions his reply was rather Jeff Spicoli: I don’t know. And he’s supposed to be an expert in this field.

Mr Bernanke does not need lessons about the painful deleveraging that follows crises. His pioneering work with Mark Gertler on the Great Depression introduced the “financial accelerator”, the mechanism by which collapsing net worth crushes the real economy. This concept has been rechristened the “balance sheet recession” by Richard Koo. Stephen Gordon admits he is new to the term and notes (with some nice charts contrasting America with Canada) “it’s not pretty”. (HT to Mark Thoma). Yet until now Mr Bernanke seemed to think America had learned enough from both the 1930s and Japan to avoid either experience. Reminded by a reporter for Yomiuri Shimbun that he used to castigate Japan for its lost decade, Mr Bernanke ruefully replied, “I’m a little bit more sympathetic to central bankers now than I was 10 years ago”…

Mr Koo has argued that quantitative easing cannot help in a balance sheet recession; only fiscal policy can. Does Mr Bernanke secretly agree? He may believe as strongly as he did a decade ago that sufficiently aggressive monetary policy can prevent deflation, but not that it can create enough demand to restore full employment. This does not rule out QE3; it only means it will be pursued with less hope about the results than a year ago.

The Great Depression (during the 1930s) is a complex topic. And monetary policy played a big role in making a bad situation worse. In particular, the numerous bank runs and failures can be blamed on the Federal Reserve. Starving the banks for capital when they most needed it. But there was a whole lot more going on. And it wasn’t the stock market crash that caused it. World War I (1914-1918) is probably more to blame. That war was so devastating that it took the combatants a decade to recover from it. And during that time America exploded in economic activity and fed the world with manufactured goods and food. We call it the Roaring Twenties. But eventually European manufacturing and farming came back. Those lucrative export markets went away. And America had excess capacity. Which had to go away. (A similar boom and bust happened in the U.S. following World War II.) Then all the other stuff started happening. Including the Smoot-Hawley Tariff. Kicking off a trade war. It was all too much.

Japan’s lost decade (the 1990s) followed their roaring Eighties. When the government partnered with business. And interest rates were low. The economy boomed. Into a great big bubble. That popped. Because they stimulated the economy beyond market demand.

The lesson one needs to take away from both of these deflationary spirals is that large government interventions into the private market caused most of their woes. So the best way to fix these problems is by reducing the government’s intervention into the private market. Because only the private market knows how to match supply to demand. And when they do, we have business cycles. That give us only recessions. Not depressions.

Like a Dog having Puppies

The market is demanding more oil. But the U.S. is not meeting that demand. So gasoline prices are up. To lower those prices we need to bring more oil onto the market. And you don’t do that by shutting down the oil business.

We have high unemployment. And excess capacity. That’s not a monetary policy problem (interest rates). It’s a fiscal policy problem (tax and regulation). No one is going to borrow money to add jobs to build more stuff when no one is buying. But if you cut taxes and reduce regulations to make running a business highly profitable, people will build businesses here. Create jobs. And hire people. Even if they have to ship everything they make halfway around the world to find someone who is buying.

Running the economy is not rocket science. Because it runs itself. Like a dog having puppies. Everything will be fine. If greedy politicians just keep their hands out of it. But they don’t. And they love printing money. Because they love to spend. But the problem is that they can’t see the fiscal forest for the monetary trees.

Liberals are know-it-all smarty-pants that want to fix everything. Even the things that aren’t broken. Because they are so full of themselves that they just know how to do everything better than anyone else. Even though they have jack squat experience in the things they’re fixing. And this is why liberals are destroying this country.

Liberals hate capitalism. Because no one is in charge. No one to make things work better. Or more efficiently. So they butt in. Even though few of them have ever run a business. Or had a real job. They know absolutely nothing about business or commerce. But they went to college. Where they learned nothing useful. Got a degree in one of the social sciences. And then set out to make the world a ‘better place’. All based on what some old, long-haired, maggot-infested, flower-child hippy from the 1960s told them in those useless social science classes. And those hippies hate capitalism. When they were young, all they wanted was for Dad to pay their tuition so they could stay stoned and screw their way through college. They loved it so much they never left college. They became ‘professors’. In some useless social science program.

And they’re teaching our kids today. Keeping the spirit of the 1960s alive. Kids graduate without a clue of what capitalism is or what it has done for Western Civilization. But their professors told them capitalism is bad. That it isn’t fair. That they should hate it. And the only way to make capitalism fair and efficient is to get as much government as possible into it. These students then do as their told. And become good liberals.

Liberals are like Addicts in Need of a Fix

So these kids graduate from college programmed to disdain capitalism. And they do. They see market forces working freely without government intervention and they get that craving. Like an addict in need of a fix. Or a smoker stuck in a smoke-free building craving a cigarette. And there’s only one way they can calm themselves. By intervening.

Once upon a time, a long way from here, I worked in a small business. There was the boss. He sold and ran operations. There was his wife who helped out part time when the kids were in school. And there was me who did everything else in the office. Sales were increasing. The business was growing. We were getting busy. And I was working late. Work piled up on my desk. And it bothered the boss. He thought it was me. I was just not working fast enough. So he went to some business seminar at a local bookstore and bumped into a consultant. And he hired him.

The consultant was married to a CFO at some big company. He stayed at home to raise their son. And consulted. He used to run the family business (he took over after his dad died). But after he bankrupted that, he went back to school to get his MBA. Got a perfect grade point average. Smart guy. But he was only good at going to school. Well, that, and bankrupting businesses.

Those who Can, Do. Those who Can’t, Consult.

He started by timing me doing some tasks. He actually sat beside me with a stopwatch. Confirmed that I was working too slow. Came up with some new procedures. They might have worked in the corporate world they talk about in those MBA courses. But small business is a different beast. There’s a lot of ‘seat of your pants’ stuff. Thinking on the fly. Sort of like being a Marine. You have to adapt, innovate and overcome. Throughout the day. You just can’t sit on your ass and come up with one-size-fits-all procedures.

But that’s what he did. And the boss implemented them. And I worked later into the night. Some of the tasks worked well with the new procedures. A lot didn’t. And to make those tasks fit the new procedures took an inordinate amount of time. I lost a lot of time elsewhere, too. He created an Excel spreadsheet for the boss to use for sales forecasting. The hours he had in developing this spreadsheet totaled $5,000. And it didn’t work. I actually debugged it (when you crunch numbers in a small business, a good spreadsheet program becomes your best friend). Then, when it was working, the boss didn’t use it. It was too complicated. The boss was a successful entrepreneur, but he barely graduated high school. And he never used that spreadsheet.

This consultant’s father was a successful entrepreneur. He built a successful business. He was good. His son was not. He enjoyed growing up with money. He never learned a good work ethic. He never learned the business. And he destroyed everything his father built. Sadly, not that uncommon when children take over the family business. So what does a failed business owner do? Why, consult, of course.

Good Intentions and Unintended Consequences

This guy was a liberal. When he found out I was a conservative he had to discuss politics. To flaunt his brilliance (that perfect GPA). And condescend to me. Because I was a conservative. And he was an elitist. Who married a rich woman (before he bankrupted the family business). And lived in one of the most exclusive and affluent neighborhoods. He never had a real job. And the only business he tried failed. He never had to work in his life (first a rich dad then a rich wife). He had no business experience (at least, none of the good kind). This guy had no business telling people how to run their businesses. But he did.

What’s the difference between him and the liberals in Congress? Not a whole hell of a lot. They’re both liberal know-it-all smarty-pants. With no experience in what they’re consulting/legislating. And they both leave a swath of destruction in their wake. They both put on their pants the same way. The only real difference is that when the consultant puts on his pants he bankrupts companies. When politicians put theirs on they bankrupt the nation.

Business people know how to run businesses. Politicians don’t. At least most on the left don’t. But that doesn’t stop them. They just have to step in and try to fix things. To flex those egos. They can’t help it. It’s who they are. They’re just so full of themselves. Liberals. They always start with the best of intentions. But end up crapping unintended consequences all over the place.